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Background Information For Investing Opportunities Associated With The Transition From Centralized To Distributed Energy Resources

Background information for investing opportunities associated with the transition from centralized to distributed energy resources

After Friday's (September 20, 2013) EPA proposed regulations placing curbs on power plant carbon emissions I started a line of research looking more closely at the issue. What I found was that there are several market forces converging that will likely change the nature of the power grid in the near future irrespective of the regulations.

I don't know if there is any investor interest in these issues at this time. But I thought it would be interesting to summarize a few articles I found that surface key issues.

I am going to start off with three articles that provide an informational overview of many of the issues. I will follow that with a brief summary about the impact of the EPA's proposed regulations.

In my opinion, the EPA's actions are mostly irrelevant as market forces are already in place that signal the beginning of the end for coal fired electricity generation plants in the US.



Why the U.S. Power Grid's Days Are Numbered

By Chris Martin, Mark Chediak, and Ken Wells August 22, 2013

There are 3,200 utilities that make up the U.S. electrical grid. These companies provide $400 billion worth of electricity per year, mostly derived from burning fossil fuels in centralized facilities and distributed over 2.7 million miles of power lines. Regulators set rates; utilities get guaranteed returns; investors get sure-thing dividends. It's a model that hasn't changed much since Edison invented the light bulb, and it's doomed to obsolescence.

That's the opinion of David Crane, chief executive officer of NRG Energy, a wholesale power company based in Princeton, N.J. Crane says that a confluence of technology, deregulation, cheap natural gas, and political pressure poses "a mortal threat to the existing utility system." He says that in about the time it has taken cell phones to supplant land lines in most U.S. homes, the grid will become increasingly irrelevant as customers move toward decentralized energy. Rooftop solar, in particular, is turning tens of thousands of businesses and households into power producers. Such distributed generation, to use the industry's term for power produced outside the grid, is certain to grow.

Crane suspects some utilities will get trapped in an economic death spiral as distributed generation eats into their regulated revenue stream and forces them to raise rates, thereby driving more customers off the grid.

Anthony Earley Jr., CEO of giant Pacific Gas & Electric, doesn't share Crane's timetable for the coming disruption. He thinks it's further out, but he does agree about the seriousness of the threat. Solar users drain revenue while continuing to use utility transmission lines for backup or sell their power back to the power company. Earley questions how power companies pay for necessary maintenance and upgrades of the transmission system [the grid] if the free ride continues? So far regulators in Louisiana, Idaho, and California have rejected calls to impose fees or taxes on solar users.

A July report by Navigant says that by the end of 2020, solar photovoltaic-produced power will be competitive with retail electricity prices, without subsidies, in a significant portion of the world. []



Game Changers to the U.S. Electric Utility Industry.

The Edison Electric Institute recently released a report entitled "Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business" [].

The report describes what it terms as a series of disruptive innovations that are encroaching on Electric Utilities. The changes are due to convergence of factors such as:

* Enhanced focus on development of new distributed energy resources [DER] technologies in conjunction with falling costs.

* Increasing customer, regulatory, and political interest in demand side management technologies.

* Government programs to incentivize selected technologies.

* Declining price of natural gas.

* Slowing economic growth trends.

* Rising electricity prices in certain areas of the country.



In an article appearing in Forbes that discusses the Edison Electric Institute's publication, Peter Kelly-Detwiler reports that these factors are potential "game changers" to the U.S. electric utility industry, and are likely to dramatically impact customers, employees, investors, and the availability of capital to fund future investment. []

That Edison Electric Institute publication suggests that financial markets are not aware of the scope of disruptive potential. The publication further suggests that with the advent of demand response, distributed generation [behind-the-meter solar, storage], and increased end use efficiencies, revenues may fall and new tariff structures may become necessary.

If tariffs for capacity or kilowatt-hours are raised to compensate for declining centralized generation utilization, the effect may be to further drive customers away from a centralized grid system.

Germany and Australia:

In some overseas markets with high tariffs, the push to distributed generation is proceeding more rapidly than in US market. CEO Peter Terium of RWE (RWE AG ), one of Europe's largest utilities, stated in 2012 "Our core markets are changing remarkably fast." With 32 gigawatts of solar, 40% of that on residential rooftops, consumers are now both producers and consumers. The success of this transformation of the energy industry will be decided at the local level.

[Note: there are definite signs that the transition in Germany is proceeding too rapidly.] []

RWE is already living the Edison Electric publication scenario. With the advent of solar, as well as increasing end-use efficiencies, the utility now forecasts declining electric sales from now to 2035, with mid-afternoon peak demand falling almost 20% from just over 24,000 MW to 19,000 MW.

Australia is looking at similarly rapid and significant changes, having gone from 20,000 solar rooftops in 2008 to over 1,000,000 as of March this year (2013). Australian utilities are struggling to cope with this change, and looking to find new ways to remain relevant to customers.

In the US:

NRG's CEO David Crane recently indicated that solar power and natural gas are coming on strong, and that some customers may soon decide they do not need a centralized electric utility. He predicted that within a short timeframe, we may see technologies that allow for conversion of gas into electricity at the residential level. If this occurs, one could expect a significant impact on the value of existing generation companies as well as the value of electric distribution utilities.

[I looked into the technology that Crane was referring too and found the following example of a direct conversion of natural gas to electrical power and heat. Redox's Power SERG 2-80, also called "The Cube," that connects to a natural gas line and directly electrochemically converts methane to electricity. The first generation, scheduled for release in 2014, has a nameplate capacity of 25 Kw, which can power a gas station or small grocery store, and is roughly the size of a dishwasher. The system can presumably run at an 80% efficiency when used to provide both heat and power.] []

By the way, The Cube uses Rare Earths to function - []

It remains to be seen if Redox can deliver what it promises, but the point is that technological advances are likely going to substantially modify the market environment for large electric generating/ utility companies in the next ten years.



Changes in the U.S. Regulatory Environment

Curbs on power plant carbon emissions.

The Obama administration on Friday [September 20, 2013] announced regulations setting strict limits on the amount of carbon output that can be generated by NEW U.S. power plants. The proposed regulations quickly sparked a backlash from supporters of the coal industry and are certain to face legal challenges. []

The new EPA guidelines make it nearly impossible to build economically feasible new coal plants without using expensive technology to capture carbon emissions.

In practical terms, the proposed regulations are likely to be irrelevant because economic/ technological forces are already reshaping the power markets.

Current natural gas-fired power plants are already within the rule's emissions limits without requiring new equipment. That means natural-gas fired plants, already by far the cheapest power plant to build and operate, will likely remain the top choice for utilities.

While coal will continue to be an important fuel for electricity generation in the U.S. the country will get less and less coal from high-cost Appalachian mines. Companies with large Appalachian operations, such as James River Coal (JRCC) and Alpha Natural Resources (ANR), will likely suffer. []